Property prices in Dhaka – the next accident waiting to happen?

A friend of mine recently told me during a conversation that the price of an apartment in Dhanmondi is now Tk 30,000 per square feet (sq. feet). I was absolutely flabbergasted!

I knew that apartments in places like Gulshan, Banani and Dhanmondi were very expensive, but Tk 30,000 per sq. feet just sounded crazy. That morsel of information left me quite intrigued, enough to spend a weekend trolling through the internet for data on land/property prices in Dhaka. It turns out – no such data source exists, at least not online.

However, I am able to offer a bit of anecdotal evidence. When apartments first started going up in Dhanmondi in the late-90s, they were selling for around Tk 3,000 per sq. feet. Assuming that the price was Tk 3,000 per sq. feet in 2000, apartment prices have risen 10 fold in a period of 12 years. That implies an average annual growth rate of about 21%.

That is roughly in line with the findings of a survey conducted by the Real Estate and Housing Association of Bangladesh (REHAB), which showed that land prices (not apartment prices!) had risen by 300% in Dhanmondi between 2000 and 2007 (see link), implying an average annual growth rate of about 17%.

So why is this happening? What is driving up the price of land/apartments so exponentially?

There are two answers – both of them are very intuitive, but one is more obvious than the other.

First of all, land will, and should, always be expensive in Bangladesh. We are a very small country, and there's (officially!) about 150 million of us packed into this little piece of real estate. Couple that broader demographic story with increased urbanisation and rising incomes, and you have a perfect storm when it comes to real estate inflation.

But there is more to it.

One of the reasons why land prices have risen as much as they have is because of the dearth of investment opportunities for savers.
Banks are offering interest rates of about 12-14% on fixed deposit savings. But with inflation at around 10%, the real (meaning inflation-adjusted) return on fixed deposit savings is not more than 2-4%.

The other main investment option is to invest in the stock market. And we all know what's been happening there in last couple of years.

The chart below shows annual returns on different investment options for the period between 2005 and 2011. Given how volatile the stock market can be and the low real returns on fixed deposits, why shouldn't people invest in property to turn a quick buck?

Chart: Annual returns on different investment options

Source: Bangladesh Bank, Dhaka Stock Exchange and author's calculations

So if apartment prices are rising partly due to a lack of investment opportunities, what can we do about it? A simple solution is to increase the investment opportunities available to people.

One way to do that is to allow people to invest their savings overseas. In other words, remove capital controls that prevent people from taking their money overseas.

The Bangladesh Bank is of course opposed to that idea. One of the reasons they commonly cite for their opposition is the negative impact capital account liberalisation will have on the exchange rate. The logic being – removing capital controls will lead to a flood of money leaving the country, decimating our US$10 billion foreign exchange reserves and precipitating a balance of payment crisis that will lead to all sorts of macroeconomic problems.

Whether those risks will come to pass if all capital controls are removed is a matter of serious policy debate. But in reality, we don't actually need full capital account liberalisation to serve the much narrower purpose of offering greater investment choices to savers by allowing them to invest overseas. It is possible to liberalise the capital account partially without having any impact on our foreign exchange reserves or affecting the US dollar-taka exchange rate.

How?

The answer is to allow trade with a particular country to be financed directly with their currency, and then remove capital controls with respect to that country alone.

For example, when a Bangladeshi trader imports furniture from China, our importer converts taka into US dollar and pays the Chinese exporter in US dollars, who then converts the US dollars into Chinese yuan. So there are transaction costs involved for both parties.

Direct financing of trade with China would mean that our importers can pay their Chinese counterparts either in taka or in yuan. This would remove transaction costs for one of the parties. It would lower the overall costs of trade with China, making it more efficient and thereby encouraging more trade, which is beneficial for everybody, us and them.

Subsequently, liberalising the capital account with respect to China would allow us to convert our savings from taka into yuan and invest the yuan in China, for example in the Chinese stock market. The net result is that it would provide our investors with greater choice in investment options without having any impact on the US dollar-taka exchange rate.

So if the Bangladesh Bank is worried about the negative impacts of removing capital controls, it ought not to be because there are ways of avoiding those negative impacts. It can't be done overnight and will require careful planning, but it can be done. And we must.

The main benefit of selective capital liberalisation is that it will allow the money that's floating around our economy causing all kinds of asset price bubbles – be it the stock market or the real estate market – to flow out of the economy and led to a market correction.

Allowing these hoards of cash to leave and pricking the real estate bubble now would be a far superior outcome than a market crash. The stock market crash we witnessed over the past couple of years serves as a powerful reminder of the pain market crashes cause.

The biggest mistake we can make now is to think that everything is fine and that the property price boom we are experiencing can be sustained forever. Property prices, like all other market prices, go up and down. We would be foolish to think otherwise.

I know I said earlier that land in Bangladesh should be expensive, but it doesn't mean that the price of land can't fluctuate from one year to another. The last time people forgot that little truism about markets the US housing market nosedived and caused a global financial crisis.

We would do well to remember that!

————————–
Nofel Wahid is an applied economist.